A case for greater disclosure

As part of its 2017/18 audit quality monitoring, the Financial Reporting Council (FRC) has paid particular attention to the audit of defined benefit (DB) pension balances and disclosures, on the following basis:

“The valuation of these assets and liabilities rest on a range of assumptions and management judgements and are at risk of material misstatement or manipulation through management bias”.

The outcome was a report published in July 2018, which concluded that there was scope for improvement in a number of aspects of the work carried out by auditors and their experts. In particular, auditors should clearly evidence the work done by their actuarial expert (if used) to assess the value of the defined benefits obligation. This should include getting sufficient evidence of challenges by the auditor to key changes in actuarial assumptions, and the basis on which reasonable ranges for assumptions had been determined – including why they are appropriate for that particular scheme. Recently, there has been public focus on the need for company directors to consider the impact of DB pension liabilities on the company’s future viability, and the report flags the role of the auditor in assessing whether those disclosures are adequate.

The report highlights the role of actuaries who are engaged by auditors to provide specialist input. It needs to be clear whether or not that actuary is part of the audit team – if they are, all of their working papers ought to form part of the audit file, as evidence. The FRC expects there to be detail that shows the basis for determining ranges of actuarial assumptions, and why those ranges are appropriate for the particular scheme.

However, the report does not highlight a fundamental failing in corporate reporting – there is currently no obligation under accounting standards to give full disclosure of the contents of the actuarial valuation for funding purposes or the buy-out deficit. The accounts are merely a 12-month snapshot of the risks facing a business, whereas DB pension risk continues far beyond that timeframe. A key purpose of a company’s financial statements is to enable the reader to understand the risks that funding a DB pension scheme puts on the business, and to help investors make decisions. These pension risks do not, however, need to be either explained or set out in full under the accounting standards.

This is an area that the FRC has looked at in the past. In November 2017, it reported on the outcome of a thematic review on pension disclosures, which aimed to improve the quality of those disclosures and identify good practice. Examples of suggested good (but voluntary) practice in company accounts included: disclosing contributions to be paid beyond the next 12 months; explaining that contributions are reviewed as part of each triennial actuarial valuation; explaining why deficits have increased and what actions are being taken to remedy this; and explaining the differences between valuing pension obligations for scheme funding and for accounting purposes (not least that those calculations will almost always be carried out at different dates).

Presumably, investors would want to know all this information for every company with DB pension liabilities, so it seems strange that the FRC is not lobbying the International Accounting Standards Board to change the terms of the accounting standard IAS 19. It cannot be onerous for a company’s accounts to clearly summarise, for example, details of the current actuarial valuation, the latest annual actuarial report, the schedule of contributions and recovery plan, as well as any contractual funding commitments, such as sharing future dividend payments with the scheme, and details of any contingent assets in place.

Putting this information in the public domain would better equip investors to understand a company’s ongoing viability, given its DB pension liabilities. The risk of misstatement or manipulation through management bias would be removed, where what is being published is the contents of valuation documents agreed with the scheme trustees under the scrutiny of The Pensions Regulator and in line with pension legislation.